Accounting & Ind AS Pharma Industry - WIRC-ICAI.org

Accounting & Ind AS

Pharma Industry

Contents

1Observations on Implementation of Ind

AS for Pharma

2Recent Accounting Changes

Ind AS 115 – Revenue Recognition

Ind AS 116 – Leases

3 Concluding Remarks

Page 3Accounting & Ind AS – Pharma Industry

MCA Roadmap for Ind AS Implementation

As per MCA notification issued on 16 February 2015, implementation roadmap for Ind AS is as follows:

2015-16 2016-17

April March April March

Financial statements for year ended 31 March 2017

Comparative for 31 March 2016

Opening Balance Sheet 1 April 2015

2016-17 2017-18

April March April March

Financial statements for year ended 31 March 2018

Comparative for 31 March 2017

Opening Balance Sheet 1 April 2016

Phase 1

Phase 2

► Companies listed in or outside India (debt/ equity) with net-worth Rs. 500 Crores or more

► Unlisted companies with net-worth of Rs. 500 Crores or more

► Holding, subsidiary, JV or associate companies of aforesaid companies

► All other listed companies► Unlisted companies with net-worth of Rs.

250 Crores or more► Holding, subsidiary, JV or associate

companies of aforesaid companies


Transition to Ind AS*Impact on Headline Numbers

* Source: EY Publication on ‘Ind AS Transition (Journey of Indian Corporates)’ (July 2017)

► Mixed Trend of Impact on various other KPIs such as Revenue, EBITDA and PAT

► Net Worth change driven significantly on account of First Time Transition Choices made


Transition to Ind AS – Pharma SectorImpact on Headline Numbers



Transition to Ind AS – Pharma SectorImpact on Headline Numbers



Transition to Ind ASStandards that made their presence felt*


Ind AS 101 – First Time Transition

Ind AS 109 – Financial Instruments

Ind AS 10 – Events after BS Date


Key Impacts noted

Financial Instruments ► Fair value change of derivative and Investments

► Expected credit losses recognized

► Application of EIR

Key AdjustmentsStandards

Revenue Recognition

► Fair valuation of assets & liabilities on acquisition and recognition of intangibles even if not recorded in the books of the seller.

► Impact of reversal of previously amortized goodwill

► Ind AS 101 exemption pertaining to retrospective restatement of past business combinations

Business Combinations

► Netting off of cash discounts & Incentives from Revenue

► Collaboration arrangements, Contract Manufacturing, Out-licensing arrangements

► Profit/Royalty Share arrangements

Others

► Componentization of fixed assets

► Recognition of Outsourcing arrangements as deemed leases.

► Recognition of Intangibles/Brands not recognizable under previous IGAAP

► Change in cost due to fair value accounting of Share based payments


Ind AS 116 - Leases

Ind AS 115 – Revenue From Contracts with Customers

1

2

Recognition of Revenue based on the five step model acting as a single source of revenue recognition requirements for all entities in all industries

The Accounting Change

The new standard sets out a comprehensive model for identification of lease arrangements and prescribes single accounting model to be used for all leases with limited exemptions

1 Discussion on Ind AS 115


Overview

► On 28 March 2018, MCA notified that Ind AS 115 will be applicable for accounting periods beginning on or after 1 April 2018.

► It replaces all existing Ind AS revenue recognition requirements (Ind AS 11 / 18 / Guidance note on Real estate).

► Ind AS and IFRS revenue standards are substantially aligned, with some limited carve outs.

► The new framework focuses on the performance obligations in the contract and allocating a transaction price to those obligations.

► The new model is a control model, rather than a risk and reward model.

Timeline

First revenue standard on 16 February 2015

Deferred by MCA on 30 March 2016

Full Retrospectiveapplication date

Modified retrospectiveapplication date

2014-15

2015-16

2016-17

2017-18

2018-19

Prior periods presented

Effective

Summary of the model

Core principle: Recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services

Identify the contract(s) with the customer

Identify the performance obligations in the contract

Determine the transaction price

Allocate the transaction price to the performance obligations

Recognize revenue when (or as) each performance obligation is satisfied

01

02

03

04

05

Impact

► It will be necessary to reassess contracts with customers using this five-step model, in order to understand the impact of the new standard.

► Systems and associated business processes are likely to require changes in order to achieve cost-effective compliance.

Step-wise Practical Issues under Ind AS 115

Step 1. Identify

contract

Step 2. Identify

Performance

obligation (PO)

Step 3. Determine

Transaction price

Step 4. Allocate

Transaction priceStep 5. Recognition Others

Contract

Combination

Identification of

contract

Contract

Modification

Multiple Element

Arrangements (PO)

Installation and

Warranty

Material Rights

Free vouchers /

Loyalty points

Right of return

Significant

Financing

Component

Variable

consideration

Non-cash

Consideration

Implied price

concessions

Discounts and

incentives

Estimating

Standalone Selling

Price for allocating

transaction price to

identified PO

Timing of

Recognition of

Revenue – Over time

or point in time

Contract Costs

Principal vs Agent

Presentation /

Disclosures

Transition Method

Licenses

Measure of progress

– Input v/s output

method


Global

Scenario

Practical experience - Global / Indian scenario

Indian

Scenario

IFRS 15 became effective globally for periods beginning from 1 January 2018

Ind AS 115 became effective in India for periods beginning from 1 April 2018

Entities mostly likely affected by Changes – Q1 and Q2 impacts

► Construction and engineering entities that enter into contracts that provide for performance obligations, allow for contract modifications or contain significant financing components.

► Retail & consumer and Pharma entities providing rights of return to customers, selling products through distributors or resellers, providing customer options for goods or services and licenses and franchising arrangements.

► Telecommunications entities selling post-paid contracts to customers impacting variable consideration

Entities affected / mostly likely affected by Changes – Q1 impacts

► Real Estate – Many Companies transitioned from POCM to Completed contracts method of revenue recognition like DLF, Prestige Estate Projects, Sobha Ltd

► Pharma – Many Companies did not report major impact on transition, as they transitioned using modified retrospective approach

► Retail - A large retail apparel brand “Shopper’s Stop Limited” reported huge reduction in its revenue on account not meeting ‘transfer of control’ criteria in case of sale or return basis arrangements.

Practical experience -Implementing Ind AS 115


Life Science Sector

► Application of Ind AS 115 will require lifesciences entities to use greater judgment.

► The flow of product through the supplychain of a life sciences entity triggers awide range of commercial transactions andevents which fall within the scope of Ind AS115.

► For example, the potential for rebates anddiscounts will impact estimates that arerequired for determining the transactionprice.

► These estimates will need monitoring on anongoing basis to identify any changes tothe transaction price.

Life sciences landscape: why it maybe more challenging

Customers/payers Products Contract type/terms Geography

Arrangements can vary by market

Licences of IP

Milestones

Right of return

Variable consideration

Gross vs. net

Reseller/distributor arrangements

Outcome-based

Collaboration agreements

Cost sharing

Patients

Physician

Hospital

Government agency

Pharmacists

Wholesalers

Specialty distributors

Competitors

Implementing Ind AS 115 – Distribution Channels


► Is this a contract with a customer?

► Contracts with oral or implied terms

► Services contract or collaboration agreement?

► Contract combinations

► Products sale contracts including services (medical devices, product or sale support)

► Co-development and co-marketing contracts

► Transportation and insurance as separate POs?

► Principal vs. agent analysis?

Step 1: Identify the contract

► Stand-alone selling price:

► Stand-alone selling prices may not always be observable

► Need to apply appropriate estimation method (if applicable)

Step 4: Allocate transaction price to POs

► When does control transfer?

► Licence agreements (right to access versus right to use)?

► Recognition of sales-based royalties

► Recognition of milestones payments

Step 5: Recognise revenue

Life

sciences

Step 2: Identify the POs

► Variable consideration (e.g., rebates, milestones, performance bonuses, right of returns) and the constraint

► Sales to distributors or resellers and consignment stock

► Financing component (e.g., long-term R&D contracts)

► Consideration paid to customers

► Will your systems and procedures enable you to identify variable consideration at contract inception?

Step 3: Determine the transaction price► Contract costs: costs to obtain the contract

Costs and other issues

Implementing Ind AS 115 – Key Issues


Practical experience - Implementing Ind AS 115


Transition choice - Full vs modified retrospective adoption

*Entities may elect either to apply Ind AS 115 only to contracts that are not completed, or to all contracts, including completed contracts, at the date of initial application.

Factors to consider while choosing the approach include:

► The number of contracts to be restated

► The length of contracts: long-term vs short-term

► The ability to obtain historical information

PY(2017-18)

CY(2018-19)

Disclosures

Full retrospective(with optional practical

expedients)

Contracts under new standard Ind AS 115 and Ind AS 8 disclosures apply

Modified retrospective(Cumulative effect at date of

application)Contracts not restated

Existing* and new contracts under new

standard

Existing and new contracts compared using current Ind AS

(e.g., Ind AS 18) in CY

Cu

mu

lati

ve

catc

h-u

p

Contracts restated

Cu

mu

lati

ve

catc

h-u

p


Next stepsWhat management can do now

Issues and steps What can management do now?

Gain a general understanding of the standard

► Involve appropriate business unit and finance personnel in Ind AS 115 training sessions

► Stay abreast of latest developments from the FASB, IASB and other regulators

Perform a preliminary assessment of both the accounting and business impact of the standard

► Gather a representative (but judgemental) sample of contracts

► Analyse your commercial relationships with customers over the life cycle of these contracts

► Perform an initial analysis of the accounting rules and develop views about new accounting policy

► Identify both financial and operational risks and judgements (e.g., evaluation of performance obligation, determination of when control is transferred, assessment of the impact of rights to return, warranties and other key contractual terms) by assessing the needs of the business along the contract life cycle

► Include an assessment of necessary disclosures in the financial and operational risk assessment

► Include an assessment of current contract management capabilities in the financial and operational risk assessment

► Form a view of the impact of the accounting changes on key financial ratios and performance, indicators (e.g., gross margins) over the term of the business plan

Interact with the market to exploit both accounting and system solutiondevelopments

► Stay abreast of industry developments and amendments to the standard that may be issued by accounting standard setters

► Initiate discussion with peers on industry-specific revenue recognition issues

► Participate in both sector and generic system development to influence and exploit new solutions

2 Discussion on Ind AS 116


Overview

► IASB issued IFRS 16 in January 2016 which replaces the existing IAS 17 for financial periods beginning on or after 1 January 2019.

► ASB of ICAI issued exposure draft on Ind AS 116 Leases on July 18, 2017.

► Lessees will have a single on-balance sheet accounting model for all leases, with exemptions for short-term leases and leases of low-value assets.

► Lessor accounting is substantially unchanged.

► Lessees and lessors will have additional disclosure requirements compared to current accounting.

► The new standard could have broad implications for entities’ finances, operations and EBITDA.

► Implementing the standard could require an entity to develop new processes and controls or adjust existing ones to identify and account for leases.

► New standard is expected to be effective for annual reporting periods beginning on or after 1 April 2019. Early application not permitted.

IFRS 16 to cause an impact on ~$2.86t off-balance sheet Leases over a sample of 14,000 listed companies – as per a study

published by IASB in a publication: ‘Effect Analysis IFRS 16 Leases’


MCA issued a Exposure draft on new standard Ind AS 116 Leases. The Ind AS 116 replaced all previous accounting standard on leases Ind AS 17

2019

► Effective date of implementation- 1 April 2019

► Post migration monitoring

► Keeping update with Ind AS 116

2018

2016

► Impact assessment

► Accounting policy adoption

► Single repository for lease contracts

► Data, systems and processes’ compliant

► Reporting and disclosure requirements

► Development of lease strategy

► Start Leases comparative period

Ge

ttin

g In

d A

S 1

16

re

ady

Ind AS 116 - Sector Impact

Sector Level of impact Effort to comply

Telecom H H

Banking M H

Retail H H

Mining H M

Oil and Gas M M

Construction L M

Insurance M L

Heat map

Low

Medium

High

Kickoff Stalled

2018: key year to prepare

Diagnostic

Design & Plan

Application

Percentage of IFRS/US GAAP listed companies that disclose off-balance sheet Leases1

Asia Pacific 43% North America 62% Africa/ Middle East 23%

Latin America 23% Europe 47%

Note: As per a study on Ind AS 116 effects by IASB

Setting the ContextApplying Ind AS 116


Property (land, office building, store etc.)Plant and equipment (vehicle, IT assets)Office equipment

Setting the ContextApplying Ind AS 116

MAC issued a new standard Ind AS 116 Leases. The Ind AS 116 replaced all previous accounting standard on leases Ind AS 17.

What is Ind AS 116?

New Leases standard by MCA

April2019

Effective Early application not permitted

Understanding Ind AS 116

Recognise assets and liabilities for most Leases that may currently account for as Operating Leases:

Lessees permitted to chose transition period:• Full retrospective; or• Modified retrospective

Need to review all contracts to identify the impact areas

Key Judgements and estimates

► Is it a lease?

► Are there non-lease components in the contract?

► Should the practical expedient for short-term leases be considered?

► What is the lease term, considering renewal, termination and purchase options?

► Are there variable lease payments and residual value guarantees?

► What is the lease classification?

► What is the discount rate?

► Does the transaction qualify for sale-leaseback accounting?

► Which transition approach to be adopted in IFRS – full retrospective or modified retrospective?

Identifying Lease contracts

The contract represents or contains a Lease The contract does not represent or contain a Lease

Yes

Customer

YesNo

Yes

Neither; how and what purpose is predetermined Yes

Supplier

No

No

NoNo

Is there an identified asset? 2

Does the customer or supplier have right to direct, how and for what purpose the identified asset is used throughout the period of use?

Does the customer have right to obtain substantially all economic benefits from the use of identified asset throughout the period of use?

Does the customer have right to operate the asset throughout the period of use, without the supplier having the right to change those operating instructions?

Did the customer design the asset (or specific aspects of the asset) in a way that predetermines how and for what purpose the asset will be used throughout the period of use?


Recognition and measurement

► A lessee applies a single lease accounting model under which it recognises all major leases on-balance sheet

Balance sheet

Asset= ‘Right-of-use’ of underlying asset

Liability = Obligation to make lease payments

Profit and Loss

Lease expense = Depreciation + Interest

Consider exemptions - Short-term lease and lease of low-value assets


Lessee accounting: Initial measurement– ROU

Lease liability

Initial direct costs

Estimated costs to dismantle, remove or restore, measured In accordance with Ind AS 37

Prepaid lease payments (eg. Deposit)

Lease incentives Received

Right-of-use-asset


Impact on financials

► Companies with operating leases will appear to be more asset-rich, but also more heavily indebted

Asset Liability

Impact on balance sheet

Impact on statement of profit and loss

► Total lease expense will be front-loaded even when cash rentals are constant

Depreciation Interest

Cash rental payments


Impact on financials ratios

GearingEBITDA

EPS (in early years)

Net assets Interest cover

Total assets

RatiosProfit/loss Balance sheet

Practical Implementation Issues

Practical Implementation Issues

Non-lease components

Separate non-lease components (e.g. services)

Practical expedient (policy) –account all as a lease

1Combining contracts

Negotiated as packaged with single objective OR

Price of contract depends on price / performance of another

2Sub leases

Generally treated as two leases unless meet contract combination requirements

3Measuring variable payments

Lessee shall include variable payments as part of lease liability

Lessor shall include variable payments as part of rental income

Intra-group leases

To be evaluated for standalone financial statements

54Initial Direct Costs

To be included as part of the right of use asset and

6


Lease implementation journey

Future state

Current state

1. Understand current state of leasing and revenue activities

(e.g., lease procurement, revenue contracts administration, and accountingand reporting)

2. Identify changes resulting from the new standards (e.g., data gaps, processes, controls, systems and tax)

5. Transition to the new standards for both leasesand revenue recognition

3. Design solution for accounting change

(e.g., new accounting policies, processes, controls and

systems) to capture new lease data requirements

and understand financial statement impact

4. Implement new accounting policies, processes, controls and systems, as well

as changes to financial statements and disclosures


Key Disclosures - Lessee

Quantitative disclosures

Income statement Balance sheet

Financial Statements

Cash flow statement

►Maturity analysis of lease l iabi l i t ies

►Carrying amount of r ight -of-use assets (by class)

► Amortization expense for right-of-use assets

► Short-term lease expense

► Small ticket lease expense

► Variable lease expense

► Interest on lease liabilities

► Income from subleases

► Sale and lease back

► Cash outflow for leases

► Additions to right-of-use assets

Qualitative disclosures

► Nature of lessee's leasing activities

► Future cash outflows to which the lessee is potentially exposed that are not reflected in the measurement of liabilities:

► Variable lease payments

► Extension and termination options

► Residual value guarantees

► Leases not yet commenced which the lessee is committed

► Restrictions or covenants imposed by leases

► Sale and lease back transactions


Transition date – Retrospective Vs Modified approach optionLessees are permitted to choose between two transition approaches applied consistently to all leases

► Full retrospective► Modified retrospective

Retrospective application or modified approach?

Option 2A –

► Measure asset as if Ind AS 116 had been applied from lease commencement (but using incremental borrowing rate at date of transition)

Option 1 – Retrospective

► Restate comparatives as if Ind AS 116 always applied

Option 2 – Modified (Do not change comparative FS)

► Difference between asset and liability recognised in opening RE at transition date.

► Operating Leases:

► Calculate present value of remaining lease payments for existing operating leases using incremental borrowing rate at date of transition.

► Choose how to measure ROU asset on lease-by-lease basis:

Option 2B –

► Measure asset at amount equal to liability (adjusted for accruals and prepayments)

Thank you

CA Jalpa Sonchhatra

[email protected]

Accounting & Ind AS Pharma Industry - WIRC-ICAI.org

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